The technical definition of day trading is buying and selling shares within the same day the share markets are open with the intention to make a profit from day time market volatility. Also known as intraday, this can mean holding stock for hours, minutes and even seconds!
In New Zealand, the term ‘day trading’ is often used to mean frequent trading by active traders who buy and sell shares in quick succession over a short period of time aiming to make a profit, aka, frequently but not necessarily intraday trading. Technically, this kind of frequent trading is called swing trading. In keeping with our Kiwi lingo, in this article we use ‘day trading’ to mean any frequent buying and selling by a trader whose intention is to make a quick profit in the very short term of holding shares.
Time to delve into the details of day trading, looking at New Zealand and US regulations, the pros and cons, and tax implications for what is considered day trading in New Zealand.
Day trading regulations
FINRA (Financial Industry Regulatory Authority) in the US, and the FMA (Financial Markets Authority) in New Zealand regulate day trading activity for enforcement and tax purposes. FINRA classifies someone as being a pattern day trader (PDT) when they complete’ four or more ‘day trades’ within five business days’, and being a PDT comes with a whole list of requirements.
On their website, New Zealand’s regulator, the FMA, suggests investors be cautious and understand the risks of day trading as well as any tax responsibilities that come with being a ‘trader’. According to 2021 FMA retail investor research, just 2% of Kiwi retail investors at the time were classified as day traders, saying that they bought and sold shares frequently during a week, with another 5% saying they bought and sold shares ‘at least weekly or fortnightly’, while the majority of those surveyed (including some Hatch investors!) said they were investing for the long term.
Pros and cons of day trading
The pros of day trading
- Quick outcomes - In a world where instant gratification drives many of our online experiences, day trading can provide just that. Active traders with real-time charts and insights can watch a stock price move up and down as they’re traded throughout the day, and can choose to buy and sell by anticipating when a company’s stock will go up or down based on perceived value of that stock. If a trader bought shares at a low price and sold at a higher price, they’d have made a quick profit, as intended. If, however, they bought shares at a low price and the price drops even lower, they may have made a quick loss. Either way, the outcome is known quickly.
- Potential income stream - Experienced traders who know what they’re doing, who understand the share markets and companies listed on them, and have charting tools to track live market activity, as well as keep on top of key market data, analysts’ reports, investor announcements, may be able to grow an income by becoming an active day trader if they are successful. So, day trading is less about taking a punt, and more about interpreting trends and using data to assess whether a company seems undervalued, and buying stock and waiting for the market to catch up. According to Zip Recruitment, in March 2023, the average day trader earned between US$34,000 and US$94,266, or around US$45.32 an hour, with the majority earning between US$47,000 to US$110,000.
- No overnight worry - Active day traders in the US who buy and sell all their holdings or positions within a day in intra-day trading don’t go to bed at night wondering how the share markets may move overnight in after-hours trading. Being in a different time zone in New Zealand it’s not quite the same, but Kiwi day traders who buy and sell their positions within a day, can sleep while the markets are closed without fretting about their holdings.
The cons of day trading
- High risk - Day trading can be risky and while it may seem ‘high risk, high reward’ activity, you can see how it’s possible to lose money quickly when a guess - or calculated risk - at a stock being undervalued and the share price going up is proven wrong and the stock goes down and loses value.
- Emotional rollercoaster - The serotonin and dopamine hit of instant gratification could become addictive. At the very least, it could be filled with emotional highs and lows in quick succession. Typically, when it comes to investing, it’s recommended that you take emotions out of the equation.
- Requires a lot of time, skill and attention - Day trading requires much more than basic share market research to anticipate when a stock may go up or down. A day trader would ideally use collaborative analytical software and charts like a Bloomberg terminal (which costs around US$24,000 per year in licence fees) - although there are free tools available. Day trading also requires a lot of time and attention to learn the ropes and interpret trends, and for cumulative successes to be more than the occasional fluke. A joint study between Universities in California and Taiwan measured performance of speculators - traders who spend money when there is a ‘high probability of failure’ - found that ‘investor skill is an important feature of financial markets’.
- High cost - Because of the high volume of buys and sells, the cost of day trading can be high. Brokers usually charge fees for every trade and if you use a platform like Hatch, those broker fees are passed onto you. While $3 NZD per trade doesn’t sound like much, multiply that by several trades a day over a number of weeks, and it adds up!
Is day trading a good idea?
While a small number of active traders have made money from day trading, some studies have shown that actively trading shares may actually result in poorer investment outcomes.
If you’re thinking about quitting your job to start day trading, you might want to think again. Research from the University of São Paulo on Brazilian individuals new to day trading found that ‘it is virtually impossible for individuals to day trade for a living’.
20 years ago a University of California study - ominously titled ‘Trading Is Hazardous to Your Wealth’ - found that only around 1% of active traders grew their money more than people who put it into an Index that tracks the average performance of the share markets, like the S&P 500 fund, which tracks the 500 biggest companies listed on the US share markets. The study analysed the active trading accounts of broker Charles Schwab over six years and found that the more frequently people traded, the worse they did.
Trading has changed a lot since that initial study. Technology and smartphones have made it more accessible, enabling people to trade from anywhere at almost any time. In fact, use of stock trading apps increased 49% from 2020 to 2021 to over 130 million annual active users! But has accessibility meant an increase in the odds of success? With having no recent studies done on the topic, it’s impossible to say.
How does longer-term investing compare to day trading?
According to data scientist Nick Maggiulli, across all 1-day periods since 1915, stock market index the Dow Jones has returned a positive return of roughly 52.3%, which he explains is only a small fraction higher than putting your money on a roulette wheel at a casino.
Holding shares for a longer period, however, may significantly increase those odds. Using the Dow Jones example again, according to data scientists, holding shares for more than one year in the Dow Jones Industrial Average (DJIA), increases the probability of investors seeing a positive return to almost 70%. Holding for more than 20 years, increases the likelihood of a positive return to 96%.
Not only may the likelihood of returns improve by investing for longer periods of time than a day or week, but some studies on day trading have shown that we make terrible traders anyway, with the large majority of everyday investors losing money or underperforming the average market return when trading.
Is FOMO investing the same as day trading?
The fear of missing out (FOMO) can feel very real watching from the sidelines, but it’s not necessarily the same as day trading. FOMO investing is when you see a share price soar above market value and you think you're missing an opportunity so you jump on the FOMO train and buy shares too. As the stock price climbs higher and higher, more and more investors buy in to avoid missing out altogether - often called ‘herd behaviour’ by economists. FOMO and herd behaviour is an emotional reaction to atypical market activity that causes people to invest in an undisciplined way. We’ll say it again, emotional investing in volatile shares is best to be avoided.
Can you day trade with $100?
At Hatch we often talk about starting investing with an amount of money you could afford to lose, or the cost of a fancy meal out. So yes, you can day trade with $100, bearing in mind you need to subtract any foreign exchange fees and the cost of each trade. If you’re trading with $100 NZD, that’s around US$60, less each buy or sell fee ($3 NZD per trade through Hatch) plus the exchange fee from depositing the initial $100. In this scenario, even if you’re successful, the returns may not be worth the time needed to reap any rewards - even to pay for that meal out at the end of the day!
If you are trading your $100 through Hatch, you also need to be aware that when you sell shares, they remain ‘unsettled’ for two US business days after the trade. You can’t then use that unsettled money to buy new shares using the money that - technically - is not yours yet. Trying to buy more shares before your funds have settled results in a ‘good faith violation’, which could see you receiving a warning or having restrictions placed on your account (and therefore slow down your ability to trade).
How day trading is taxed
If you’re embarking on day trading, you need to be aware of your tax obligations, which we cover here in our Tax Centre. Specifically, when you are considered a ‘trader’ - rather than an investor - by Inland Revenue (IRD), any money you make (or lose) is considered income and counts towards your annual untaxed income.
IRD tests to determine whether you’re a ‘trader’
The IRD is governed by Section 65 of the Income Tax Act 2007, which means you could be classified as a trader (as opposed to an investor) if you spend time buying and selling shares. These are essentially:
You’re in the business of dealing shares
When you regularly buy and sell shares with a level of professionalism, especially when a portion of the money you use to invest is borrowed.
You invest with the intention of making a profit
When you buy shares with the intention of selling them for a profit, or buy highly volatile stocks to sell quickly at a gain - as opposed to holding the shares and earning income by holding them long term.
Because tax reporting in New Zealand is largely reliant on voluntary disclosure, if you think you may fall under the definition of a trader, you need to keep on top of your paperwork to show records of your intentions behind each buy and sell.
According to Deloitte, the IRD has ‘very broad information gathering powers at their disposal, enabling them to look further into share trading history and records may also assess that signal you are a day trader’. These may include undertaking a tax audit where the IRD can review up to seven years of trading activity to look for:
- An ongoing pattern of frequent buying and selling multiple shares
- Borrowing money with the purposes of investing
- Buying stocks that are considered very volatile and high risk with the intention to sell quickly for a profit
- Buying shares using a ‘revenue’ account instead of a ‘capital’ account
Sharesight goes into further detail about New Zealand’s IRD tax rules here.
Day trading tax calculator
While New Zealand doesn’t have a capital gains tax, and everyday investors are not taxed on their returns, the IRD does require that day traders pay tax on income generated through trading assets such as shares based on their intent to sell for a profit.
At the end of the day…
Day trading requires skill, time and attention to be successful. Even then, research suggests there are no guarantees of making a profit given the risks of day trading. If you’re after a ‘set and forget’ approach to growing your investments over time, day trading is unlikely to work for you.